By D.B. YOUNG

Contributing Reporter

Believing that doctors at Kaiser Permanente failed to detect his lung cancer, Wilfredo Engalla did what all Kaiser patients must do when they assert malpractice: file for arbitration.

The health maintenance organization requires members to sign agreements promising that an arbitrator will be appointed in 60 days or less. But it took Kaiser 144 days in the case of Engalla, a Hayward accountant.

Engalla died a day after an arbitrator was appointed dramatically reducing Kaiser's liability, since pain-and-suffering damages cannot be sought by survivors on behalf of the deceased.

In a landmark 6-1 ruling that grew out of the Engalla case last summer, however, the state Supreme Court said plaintiffs can take their claims against HMOs to court if they can show the arbitration process is flawed. This came after attorneys for Engalla's family showed that Kaiser took an average of 674 days to appoint a neutral arbitrator for malpractice cases, and an average of 863 days to hold an arbitration hearing.

The ruling, which resulted in Kaiser's decision this month to scrap its in-house arbitration service, reflects the growing role of the courts in the HMO industry.

Federal law says that only doctors not corporations can be held liable for punitive damages when a patient suffers ill health from bad medicine.

As a result, patients denied adequate care can sue their doctors when things go wrong. But when it comes to suing their HMOs, punitive damages are seldom allowed, and unhappy patients are usually limited to recovering the cost of the care they were denied.

Even so, a handful of lawyers have exploited loopholes to breech the wall protecting HMOs from major liability.

One of the most creative law firms at wringing liability dollars has been Hiepler & Hiepler of Oxnard, which won an $89.1 million judgment from Health Net in 1993 for the family of the late Nelene Fox. Fox's family sued Health Net after the HMO refused to pay for a bone marrow treatment for her breast cancer.

Hiepler & Hiepler partner James McGinley said the firm exploited a loophole in federal law that allows employees of government entities to sue their HMOs for punitive damages. Fox happened to be a public school teacher. (To avoid an appeal, the Fox family ultimately settled with Health Net for a lesser, undisclosed sum, McGinley added).

Hiepler & Hiepler scored a similar success in the case of another schoolteacher, Inland Empire resident Christine DeMeurers.

DeMeurers was also denied a bone marrow transplant to treat her breast cancer and later died. In that case, an arbitration panel found in DeMeurers' favor in 1995 and awarded the family $1.2 million for intentional infliction of emotional distress, said McGinley.

The HMO liability armor is also being challenged, in a roundabout way, by Keya Johnson, who gave birth to a boy who had to be resuscitated on delivery and was left with a paralyzed arm.

Johnson and her lawyers filed suit against Cigna HealthCare of California on the grounds that it engaged in false and misleading advertising saying she thought she would get services which were later denied.

Johnson's right to sue on the basis of false advertising was upheld in a Superior Court ruling in 1995, and again on appeal in 1996. But the same appeals court that upheld the ruling in 1996 agreed to reconsider its decision last fall, casting doubt on whether the case would go forward.

Other high-profile cases that appear to involve HMOs have, for the most part, really been cases against doctors or physician groups that allegedly withheld care from patients under pressure from cost-conscious HMOs.

In one of those cases, the family of Joyce Ching sued her Simi Valley doctors, claiming medical incentives led them to delay and deny medical tests to diagnose and treat her cancer, which ultimately killed her. Ching's family received a jury award of $3 million in 1995, which was later reduced to about $700,000.

And in another high-profile case, the family of Christina Louise Rutledge of Yorba Linda, who eventually died of cervical cancer, sued the Friendly Hills Medical Group of La Habra, and received a jury award of $10.9 million in April last year.

The doctor liability issue also makes Kaiser Permanente vulnerable to big lawsuits, since Kaiser directly employs all its doctors. By comparison, nearly all other major HMOs contract with their doctors and have no direct employment relationship.

Kaiser's unusual vulnerability has ended up putting it on the losing end of several major liability cases, including one last December in which the company settled a case with a Texas man for $5.35 million after a "test jury" empaneled by defense lawyers appeared inclined to make an even higher award. The case involved a 56-year-old electronics technician who collapsed and died at a Kaiser clinic in 1995.

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